As commodity prices continue to fall, U.S. consumers are feeling much better than economists expected, according to the preliminary consumer sentiment survey from Reuters & the University of Michigan on Friday. However, a less pessimistic reading doesn't mean consumers will rush out to spend their money, economists say.

The index soared over 10 points to 73.1 from last month's 63.0 reading, while one-year inflation expectations dropped dramatically to 3.6% from August's 4.8% reading, the biggest monthly drop in nearly three years.

Paul Ashworth, senior U.S. economist at Capital Economics, said it's "encouraging" that consumers are feeling better due to falling oil prices, but he explained the retail sales report earlier in the morning suggests that rising confidence doesn't translate into increased spending. He also said it's worth remembering that confidence levels are still "relatively depressed."

James Knightly from ING said it's possible that lower prices at the pump could translate into discretionary spending, but with unemployment rising and assets prices falling, he explained it is "doubtful" that the report "signals a major turnaround in the consumer sector."

The economic conditions index moved up to 76.5 from the prior month's 71.0, while the economic outlook index moved up to 70.0 from August's 57.9 reading.

BMO economist Jennifer Lee said the release was "much-needed ¥ on this dreary day." But she also said increased confidence won't be enough to prevent a negative third quarter in U.S. consumption.

Five-year inflation expectations fell to 2.9%, down from 3.2% last month and down half a percentage point from the cyclical peak of 3.4% seen in both May and June.

"This should help to ease the Fed's fears about inflation becoming embedded through a wage-price spiral," Knightly said. "With inflation set to drop sharply and downside economic risks persisting we continue to look for Fed rate cuts in 1Q09."

The major improvement contrasts with the weekly survey of consumer comfort from ABC News. The survey remained at -47 last Tuesday, just four points away from its record low.

The Michigan sentiment survey is the first major look at consumer confidence for September.

By Patrick McGee and edited by Sarah Sussman
©CEP News Ltd. 2008